Opportunities and Challenges for Islamic Finance Amidst Arab Spring

With political upheavals left right and center in the Arab world, much attention has focused on the incoming regimes in these countries. The political turmoil that hit the Arab region houses majority Muslims and has led to complete regime changes in Tunisia, Egypt, Yemen and Libya, with major governmental changes in other parts with Monarchy still holding on.

INCEIF Research Department, Issue #01, May 2012, www.inceif.org

With rise of new political systems, focus is shifting towards providing real economic solutions for addressing the people’s problems and accedes to their wishes of doing it within the limits of Islamic principles. The potential for Islamic finance to step in and explore opportunities is immense owing to its nature of basics on “Real Economic Activity” and risk sharing mechanisms. With majority Muslim populations in the region adhering to their religious norms via Islamic financial instruments for economic solutions, the time is ripe for Islamic finance to enter the mainstream financial markets in the region.

The region is hardly been penetrated by the banking industry with banking penetration in Egypt standing at 10%, while in Morocco at 25% and Tunisia at 33%. McKinsey reports North Africa contributing a mere 1% to the trillion dollar Islamic financial assets globally with Egypt being the leader in the region with a mere 5% of its banking assets in Shariah compliant.

With the dust settling in some parts post prolonged civil unrest, the region is embarking on long term development initiating from infrastructural development. This is an area where the risk sharing mechanism and focus on asset and economic development of Islamic finance, raises the potential for growth of the industry. African Bank of Development has already reported approximately $2.4 billion worth of Islamic project financing in the region spanning 24 projects.

Country

Tunisia

Algeria

Lebanon

Jordan

Mauritania

Sudan

Oman

Saudi Arabia

Egypt

Yemen

Iraq

Bahrain

Libya

Kuwait

Morocco

Western Sahara

Syria

Protest Initiation

December

December

February

January

January

January

January

January

January

January

February

February

February

February

February

February

March

2010

2010

2011

2011

2011

2011

2011

2011

2011

2011

2011

2011

2011

2011

2011

2011

2011

Current Status of Political Unrest

Finished in March 2011

Reduced since April 2011

Limited Protests

Currently Ongoing

Currently Ongoing

Reduced since April 2011

Finished in May 2011

Sporadic protests in Eastern Province, women’s rights campaigns ongoing

Government kicked out in February 2011

Government kicked out in February 2011

Finished in December 2011

Currently Ongoing

Civil War ended in October 2011

Finished in December 2011

Finished in November 2011

Reduced since May 2011

Currently Ongoing

Extent of Impact

Regime Change

Widespread Protests

Widespread Protests

Governmental change but Monarchy still in Place

Minor protests

Minor protests

Governmental change but Monarchy still in Place

Minor protests

Regime Change

Regime Change

Major protests

Ongoing civil disorder and partial governmental change

Regime Change

Governmental change but Monarchy still in Place

Governmental change but Monarchy still in Place

Minor protests

Ongoing civil disorder and partial governmental change

How to address some of these challenges the issue roles down to commitment of the institutions and the regulators to actively manage and overcome these challenges with support from human capital development institutes.

• AcademicinstitutionsandKnowledgeCentresneedtoplaytheirroleindevelopingcurriculaand executive programs providing a balanced skill set of Shariah studies and Business & Finance.

• Governmentsneedtostepinandkick-starttheIslamicdebtmarkettoprovideavenueforIFI’sto legitimately invest capital via short term Sukuk issuance.

• InternationalregulatorybodiesinIslamicFinancelikeIFSBetc.canfurtherdwellintotheseareasanddevelop comprehensive risk frameworks according to specifications of Islamic financial services in this region.

• ThequestionofRealEconomy,boilsdowntofocusoninfrastructuralfinancingand commitment for not mere Shariah compliance, but a Risk Sharing based approach from IFI’s. Instruments fortheseactivities,arethereandavailable,thequestionistocustomizethemforspecificneeds.

With low penetration of banking sector, and massive need for development sector funding, the timing is right for addressing some key challenges before we can embark on sustainable growth of Islamic finance. Butthequestionofhowtoharnessandregulatethisisessentialandonusontheregulatorsofthe country. The key challenge that needs to be addressed before embarking is the framework of governance and human capital development.

• Balanced skillset of Shariah and Finance, Do we have experts? The current best practice for Shariah compliance is employing a Shariah expert to stamp the activities andstampit.Butwhatifthe“scholar”doesnothavetherequiredacumenoffinance?Howcanthisbemanagedbytheindustryandtheregulator?

• Making Intra IFI -IFI and Inter IFI – Central Bank relationship Shariah Compliant? The infrastructure and laws at firm level institutions can be replicated from developed Islamic financial markets,butthetransactionalandregulatoryrelationshipbetweenCentralbankandIFI’sneedtobeShariahCompliantaswell.

• Addressing Unique Risks of Islamic Financial Contracts The risk profile of Islamic financial activities is different from its conventional counterparts. How and Who woulddevelopandapplygovernanceregulationsforthisissueforeachjurisdiction?